The intent of this chapter is to examine how governments handle the accounting and financial reporting of long term items, in particular, long term obligations and long term fixed assets. A detailed definition can be found in the lesson on Definitions, Importance, and Types of Long Term Items . A brief defined follows:
Long term items have two major impacts on government. One is the actual impact; the other, the impact on accounting and financial reporting. Both should be related to each other. However, because governmental accounting and reporting is oriented to the short term, the actual impact of long term endeavors may be different from the reported impact in the governmental financial statements. The actual can bring significant benefits or burdens, but neither will necessarily be apparent in the financial statements.
The compliance and liquidity approach, which was a lesson in chapter 2 , holds sway in governmental accounting and financial reporting and has a significant role in how long term obligations and assets are handled. The place of long term items in the compliance and liquidity model is given attention in a lesson in this chapter. In essence this model emphasizes annual budget items over long term activities. Thus, distorts may arise in reporting on long term items.
If governments used an accrual and consolidation logic , which was coved in chapter 2, the results in the governmental funds could be different and assessment of success and conditions might be worse, although it is difficult to realistically compare the two models in the abstract.
Among the long term obligations (liabilities) of government are:
Among the long term assets, including fixed and intangible assets are:
Long term debt which is discussed in detail in this chapter can arise from many sources. One type is bonds. Governments can use many different types of bonds to raise money, usually depending on how the government wants to or can pay back the money. Types of bonds include: term, serial, and deep discount.
With term bonds, all the principal is due at one time and the interest is paid while the principal is outstanding. With serial bonds, the principal is paid off at intervals; for example, an equal amount each year. With deep discount bonds, all the interest and principal are paid off at one time. This means the government receives some money and does not have to pay back anything, but then all the money must be paid at one time.
Bonds are typically sold to pay for major capital projects , although bonds have been sold to handle current expenditures or shortfalls in pension plans as well as for a variety of other purposes.
How to pay back the bonds is a major issue for government? Although there are many types of bonds, the method for determining how much to save to payoff the bonds is not very different. The method depends on facets of time value of money calculations . In the case of money invested to pay for principal due in the future one needs to understand annuities and compounding , that is, periodic investments and the interest that can be earned on the investment plus the interest earned on the interest.
Although borrowing via bonds does not get the type of attention in the financial statements as in the case of business accounting, governments still do some reporting in the statements on long term debt. When bonds are sold to raise money for capital projects or other reasons, the proceeds are included in one of the funds, often the capital projects fund. They are placed under a category called " other financing sources " in the statement of revenues, expenditures, and changes in fund balances. In essence borrowing is used to offset spending which is different from the business approach where only revenues can be used to offset spending.
Unlike the bond proceeds, the long term bond obligations that arise from selling the bonds are not included in the governmental funds until money has to be paid. Obligations, whether principal or interest, are kept in the general long term account group until due.
Pensions, another long term obligation, have become a part of the benefit package of employment. They provide income after retirement. Pensions are actually deferred earnings or {deferred compensations}. The worker earns the pension benefit as he or she works, but does not receive the money until retirement or in some cases other types of departures or disability.
For pensions some of the central questions are: how to calculate the payment owed in the future, how to account and report it now, and how to accumulate resources to pay for it when it comes due?
Ordinarily there are two types of pension plans: defined compensation and defined benefit.
The first is relatively easy to handle. The employer promises that whatever is put into the pension trust fund and accumulates belongs to the employee, no more, no less. The defined benefit is more complex. With defined benefits, the employer makes a promise to pay the employee at retirement regardless of what was invested and earned. Such a promise is complicated because the promise is often in terms of a formula that will not be filled in until the employee retires. Thus, the employer must invest, with its inherent risk, for amounts that can only be estimated.
Actually, it is conceivable for the government to provide very little information in the financial statements on pensions. Instead, pension information is scattered throughout the entire CAFR, with much of the information disclosed in the {notes to the financial statements} and perhaps, but not likely, in the statistical section . Some of the most insightful information on pensions obligations is in the notes to the financial statements. Here, in a section often called retirement plans will be a verbal description of the plan and how the calculations are made to determine the retirement obligations. The tables in the notes show the amount and percent under funded or over funded for the current year and for past years.
Other types of long term obligations include capital leases, sick leave and accrued vacation.
A capital lease is an obligation or liability because the government is obligated under contact, and often penalty, to pay for an asset (a building, for example) for a long period of time. Sick leave and vacation can be long term obligations because government can allow employees to build up (accrue) sick leave and vacation and get paid for time not taken when they leave or retire.
The next major lesson in this chapter was the lesson on long term fixed assets . Although long term fixed (physical) assets are a vital part of government operations and can have a significant impact on financial success , conditions , and compliance , reporting on these assets is one of the weakest areas in governmental financial reporting.
Governmental accounting and financial reporting draws a distinction between long term fixed assets and infrastructure.
Fixed assets can be building, equipment, or machinery. Infrastructure consists of the major physical assets, such as streets, sewers, and bridges. Reporting on infrastructure is optional on the grounds that finding the cost might be more trouble than benefit and it is unlikely that the government will sell these.
Acquiring long term fixed assets presents a difficult situation for government. In business circumstance, the rationale is presumably to buy a fixed asset that will generate a greater return than some other investment. In government, attention to improving the community may be the reason but fixed assets are also seen in terms of appeal to voters. Often called "pork", a fixed asset may be acquired to win the votes of certain segment or sector of the community. Thus, a community may end up with a mixture of economically viable and economically wasteful fixed assets.
A classical economic analysis for acquisition of fixed assets is discounted cash flow (DCF). In government that is often converted to cost benefit , since in government, not all results can be easily expressed in terms of dollars.
With DCF, a business would try to determine whether the discounted flow of revenues (cash) were greater than the (discounted) cost of the investment. Some discounting factor is taken based on how much the company wants to earn from its investments. The higher the discount rate, the more the firm expects to earn and the tougher it is for an investment to show a positive or competitive return. Government use of DCF can be more subjective because noncash benefits (eg, extra years of life) must be convert to dollar values.
In the financial statements of government, long term items are presented in a variety of funds, account groups and other reporting devises. Often, long term reporting will start in the capital projects fund (eg, where the borrowing takes place and the asset is acquired) and cut across the general fund (where revenue is raised and transferred to pay for the asset), the debt service fund (where money is held and invested to pay for the principal and interest), and the general long term debt and fixed assets account (where the unmatured debt and cost of fixed asset are listed). It can also start in a pension trust fund or even the general fund .
The last lesson in the chapter was a brief discussion of investment strategies . With long term activities it is prudent have a good idea not only of what to acquire and but how to save and pay for it.
One of the basic rules in investing (essentially saving) is that there is an inverse relation between risk and return . The higher the return you want the greater the risk of losing all or much of your investment. An often surprising piece of information for investors, is that random (the proverbial dart thrower) selection of securities often produces results as good as people trained and certified in financial planning.
Broadly there are two kinds of investments: real assets and financial assets.
Real assets include gold, property, and other physical assets such as silver, paintings, baseball cards, etc. Financial assets are instruments or agreements to pay and be paid back. Some investors "go for broke", hoping for that one big strike; others, always take the conservative route. One is called the risk taker; the other, risk adverse. The prudent investor, supposedly, diversifies -- some risky investments; some not so risky investments.
Governments, often by law, can be required to be prudent if not very prudent in their investment strategies. Thus, their portfolio or collection of investments would lean toward the conservative or less risky side (risk adverse).
All in all, governments borrow, borrow for long term obligations such as buildings, promise future benefits, and try to invest to pay for all the long term items. Unfortunately, reporting on these important activities is not always as clear and complete as it could be.